Municipal Tobacco Bonds Gain as Higher Yields Attract Buyers

Source from:  By Jeremy R. Cooke Sept. 5 (Bloomberg) 09/06/2007

Bonds backed by tobacco companies' settlement payments to U.S. states rose the fastest in more than two years when tax-exempt yields of more than 6.3 percent attracted investors in the last two weeks. Tobacco-settlement bonds New Jersey sold in January and due in June 2041 yielded 5.9 percent today. That's almost a half- percentage point less than on a similar trade Aug. 21 during the week when risk-averse investors pulled record sums out of high- yield municipal mutual funds. Price and yield move inversely. Outflows from the high-yield funds, which invest in municipal tobacco bonds and other lower-rated tax-exempt debt, dropped to $1 million during the week ended Aug. 29 from $303 million the week before, according to AMG Data Services. The fund category that led declines amid a broader reassessment of risk in credit markets rebounded more than other municipal funds. "The municipal tobacco sector may have seen its near-term lows," Brian Tournier, an A.G. Edwards Inc. analyst in St. Louis, said in a report. "Pricing in the sector may improve over the remainder of 2007 as credit markets stabilize." A Merrill Lynch & Co. index of tax-exempt bonds secured by annual revenue from the 1998 settlement over health costs gained 1.96 percent from Aug. 22 through yesterday. That's the most since July 2005, when the bonds gained 2.05 percent. When Michigan sold tobacco-settlement bonds Aug. 14, the state paid a 1.5 percentage-point yield premium over top-rated 30-year general obligations to sell the issue maturing in June 2048. Those securities traded at a 1.2-point premium to Municipal Market Advisors index today. Increased Demand Though August was the worst month for municipal tobacco bonds in more than three years, demand increased during the last week, Tournier said. "The concerns of some municipal investors over the market's ability to absorb the significant new supply expected over the remainder of 2007 appear to have abated somewhat," he added. Ohio plans to borrow $5.5 billion as soon as next month in its first sale of tobacco-settlement assets. Officials tapped Bear Stearns Cos. and Citigroup Inc. to manage the offering. Refinancing deals that Wisconsin and Louisiana are planning remain more dependent on market rates. "At yield levels above 5.75 percent, most potential tobacco bond refundings no longer provide adequate savings for the issuers," Tournier wrote. The Ohio transaction alone would push this year's issuance of tobacco bonds to more than $16 billion, exceeding the record $12 billion states sold in 2003, according to Citigroup. Besides the prospect of more bond sales, municipal tobacco bonds also face the risk of federal attempts to regulate and further tax tobacco products, Tournier said. Such moves could lead to bigger-than-expected declines in cigarette consumption, which dictate the size of companies' settlement payments. Enditem